February 06, 2012

After the student loan arms race: the disruption of hierarchy

I am grateful to Renee Knake for organizing this online symposium and for including me as a participant. In a former life before I went to law school and entered legal academia, I was a state budget analyst. Perhaps as a result, the financial realities of funding legal education have become something of a preoccupation of mine, and I am thrilled to see the financial issues—especially funding mechanisms and financial outcomes for graduates—getting more attention.

In this post, I will take a look at the current state of student debt—and in particular, how the student-loan-fueled arms race relates to the law school prestige hierarchy. I conclude that changing the student loan system (a prospect somesay is inevitable) will disrupt the traditional prestige hierarchy in some significant ways.

To understand the institutional effect, we have to look at some of the factors that have brought us to where we are now:

(1) Students can take out the full cost of attendance in federal student loans. This means that at least for law school, the days of private loans are gone (and this is new; even 5-6 years ago, law students generally relied on private loans to some degree). The cost of attendance includes both tuition and living expenses. If a school raises tuition, a student can take out a larger loan to meet the increased tuition. There are no restrictions on how much can be taken out by a student beyond the cost-of-attendance limit; as Paul Campos has pointed out, “This means that most law students can borrow the full cost of law school tuition and living expenses from the federal government . . . no matter how high that cost may be.” Loans for living expenses will vary widely depending on the relativecost of living in the area.

(2) Historically, law school applicants have been much more prestige-conscious than price-conscious. A recent article by Richard Sander and Jane Yakowitz found that “when students are deciding between schools of even modestly different levels of eliteness, ranking tends to drive decisions,” even though school rank was a relatively weak predictor of students’ career success. This emphasis on prestige has made law school choice fairly price-inelastic; higher-ranked schools could raise tuition without losing a corresponding number of students.

(6) Finally, the government’s new Income Based Repayment program makes applicants even less price sensitive than before by capping student loan payments at 15% (soon to be capped at 10%) of the graduate’s discretionary income for either 10 or 20 years, depending on whether the student goes into public service or works in the private sector. The remainder is forgiven, though the private-sector program carries a potential tax impact. As a recent Forbes article pointed out, “Even individuals earning $150,000 can achieve savings if they managed to rack up $100,000 or more in federal student loans by attending graduate or professional school.” Once the debt is high enough that the loan is subject to forgiveness (examples and estimates here), students’ monthly payments will not increase no matter what their debt level is. As a result, once the student’s debt level is high enough, there is no economic incentive to avoid further increases because payments will be capped at the same level—and students are well aware of that. The combination of unlimited lending and capped repayment is not unique to law; it affects all graduate programs, including medical school and dental school. The IBR program is not without risk, however; as Bill Henderson and Rachel Zahorsky have noted, “the Congressional Budget Office may have underestimated the extent to which students will be eligible for the federal Income-Based Repayment plan.” If so, IBR could potentially be subject to future budget cuts.

I believe that these factors are the prime drivers behind the rapid escalation of law-school student loan debt. And I agree with Bill Henderson and Brian Tamanaha that the trend cannot continue forever. But what happens when the system breaks? Tamanaha suggests that eventually lending limits will be put into place. An annual cap on student federal-loan eligibility would not be difficult to administer. Undergraduates already face such limits; it is only the Grad Plus program that makes law school and other graduate loans available for the full cost of attendance. The government also already has a mechanism it could use evaluate potential loan limits: the gainful employment metric proposed for for-profit colleges (and soon to be extended to nonprofit programs), which would require either that (1) in a given year, 35% of graduates are able to pay the interest on their debt plus at least $1 of principal; (2) the average graduate’s loan burden, on a ten-year repayment schedule, does not exceed 30 percent of his or her discretionary income; or (3) the average graduate’s yearly debt-service obligation (again on a ten-year payment schedule) does not exceed 12 percent of his or her total earnings.

The frequent assumption is that such limits would only affect law schools at the low end of the prestige hierarchy and the lowest-ranked schools would have to close. I suspect, however, that limiting student loans would actually disrupt the current prestige hierarchy in significant ways. With lending limits, students would be forced to become more price sensitive, giving a rankings advantage to schools that either (1) have managed to keep tuition costs down; (2) are located in low-cost-of-living areas; or (3) are associated with states or universities willing and able to support legal education. Schools without any of those characteristics will be the most disadvantaged. Looking at the last page of the US News Rankings, there is a big difference between the University of South Dakota ($11,208 per year in state) and the University of the District of Columbia ($8,850 a year in state) versus Touro ($41,070 a year) or Thomas Jefferson ($38,700); this disparity means lending limits would not affect low-ranked schools equally, by any means. And indeed all the law schools, regardless of current rank, would likely find that traditional assumptions of prestige cannot hold steady in the face of loan limits: once applicants are forced to become more price sensitive, schools’ LSAT and GPA averages will adjust as students with high credentials more often choose lower-priced schools. Interestingly, looking at the first page of the US News rankings, there is not a huge tuition differential among the most prestigious schools. But beyond the most elite, tuition and average debt vary significantly and are less correlated with ranking than many people realize. With greater price sensitivity, there is likely to be a more significant correlation between cost and rank.

What does this mean for the future?

First, schools must take a hard look at their own loan dependence and should make contingency plans for the future. Schools must plan how to fund quality legal education in the event that loans become less available, and schools should also plan for ways to minimize the student loan burden even in the current era of unlimited lending. This may mean making some hard choices: some of the most effective innovations in legal education are also among the most costly, as Michael Lewyn notes in a recent comment on The Faculty Lounge. A school’s dependence on student loans can be roughly gauged by this chart, which shows the average indebtedness per 2010 graduate, along with an estimate of the percent of students taking out loans (students at schools on page 5 and after are below the national median in law school indebtedness). If a school’s average debt burden is $145,621 per student ($48,540 per year), what would the school’s budget look like if federal lending were capped at $40,000 per student per year? What if it were capped at $30,000 per year?

Second, schools, professors, and bar admissions committees should all be aware of the loan burdens faced by new graduates. Income Based Repayment can help ease the burden for many. Nonetheless, we should not ask students to take on a large debt burden without also providing transparent data about the monetary costs and benefits of that investment decision—and we should be mindful of the fact that law students are in fact making a very significant investment.

Finally, we should all step away from the current US News rankings. Brian Leiter and others have already pointed out many flaws in the current rankings. If the rankings are likely to look radically different in the future—and I think they are—then we certainly shouldn’t base current policy choices on the rankings as they look now. As my own law school’s dean has pointed out, applicants should look at the real value of what a law school has to offer: what are the areas where a law school’s program excels, regardless of ranking? The true strengths of individual law schools have often been overlooked in favor of attention to the school’s overall ranking, but such an approach is shortsighted. The decision to invest in a law school education is not just a monetary decision, and the benefits measured in the cost-benefit equation are not just monetary gains; educational value matters. Law schools that invest in improving their ranking without also improving their educational value shortchange themselves, shortchange their students, and make an unwise investment. When we develop law school programs, we must do so with an eye toward lasting value to the students.

Comments

I am grateful to Renee Knake for organizing this online symposium and for including me as a participant. In a former life before I went to law school and entered legal academia, I was a state budget analyst. Perhaps as a result, the financial realities of funding legal education have become something of a preoccupation of mine, and I am thrilled to see the financial issues—especially funding mechanisms and financial outcomes for graduates—getting more attention.

In this post, I will take a look at the current state of student debt—and in particular, how the student-loan-fueled arms race relates to the law school prestige hierarchy. I conclude that changing the student loan system (a prospect somesay is inevitable) will disrupt the traditional prestige hierarchy in some significant ways.

To understand the institutional effect, we have to look at some of the factors that have brought us to where we are now:

(1) Students can take out the full cost of attendance in federal student loans. This means that at least for law school, the days of private loans are gone (and this is new; even 5-6 years ago, law students generally relied on private loans to some degree). The cost of attendance includes both tuition and living expenses. If a school raises tuition, a student can take out a larger loan to meet the increased tuition. There are no restrictions on how much can be taken out by a student beyond the cost-of-attendance limit; as Paul Campos has pointed out, “This means that most law students can borrow the full cost of law school tuition and living expenses from the federal government . . . no matter how high that cost may be.” Loans for living expenses will vary widely depending on the relativecost of living in the area.

(2) Historically, law school applicants have been much more prestige-conscious than price-conscious. A recent article by Richard Sander and Jane Yakowitz found that “when students are deciding between schools of even modestly different levels of eliteness, ranking tends to drive decisions,” even though school rank was a relatively weak predictor of students’ career success. This emphasis on prestige has made law school choice fairly price-inelastic; higher-ranked schools could raise tuition without losing a corresponding number of students.

(6) Finally, the government’s new Income Based Repayment program makes applicants even less price sensitive than before by capping student loan payments at 15% (soon to be capped at 10%) of the graduate’s discretionary income for either 10 or 20 years, depending on whether the student goes into public service or works in the private sector. The remainder is forgiven, though the private-sector program carries a potential tax impact. As a recent Forbes article pointed out, “Even individuals earning $150,000 can achieve savings if they managed to rack up $100,000 or more in federal student loans by attending graduate or professional school.” Once the debt is high enough that the loan is subject to forgiveness (examples and estimates here), students’ monthly payments will not increase no matter what their debt level is. As a result, once the student’s debt level is high enough, there is no economic incentive to avoid further increases because payments will be capped at the same level—and students are well aware of that. The combination of unlimited lending and capped repayment is not unique to law; it affects all graduate programs, including medical school and dental school. The IBR program is not without risk, however; as Bill Henderson and Rachel Zahorsky have noted, “the Congressional Budget Office may have underestimated the extent to which students will be eligible for the federal Income-Based Repayment plan.” If so, IBR could potentially be subject to future budget cuts.

I believe that these factors are the prime drivers behind the rapid escalation of law-school student loan debt. And I agree with Bill Henderson and Brian Tamanaha that the trend cannot continue forever. But what happens when the system breaks? Tamanaha suggests that eventually lending limits will be put into place. An annual cap on student federal-loan eligibility would not be difficult to administer. Undergraduates already face such limits; it is only the Grad Plus program that makes law school and other graduate loans available for the full cost of attendance. The government also already has a mechanism it could use evaluate potential loan limits: the gainful employment metric proposed for for-profit colleges (and soon to be extended to nonprofit programs), which would require either that (1) in a given year, 35% of graduates are able to pay the interest on their debt plus at least $1 of principal; (2) the average graduate’s loan burden, on a ten-year repayment schedule, does not exceed 30 percent of his or her discretionary income; or (3) the average graduate’s yearly debt-service obligation (again on a ten-year payment schedule) does not exceed 12 percent of his or her total earnings.

The frequent assumption is that such limits would only affect law schools at the low end of the prestige hierarchy and the lowest-ranked schools would have to close. I suspect, however, that limiting student loans would actually disrupt the current prestige hierarchy in significant ways. With lending limits, students would be forced to become more price sensitive, giving a rankings advantage to schools that either (1) have managed to keep tuition costs down; (2) are located in low-cost-of-living areas; or (3) are associated with states or universities willing and able to support legal education. Schools without any of those characteristics will be the most disadvantaged. Looking at the last page of the US News Rankings, there is a big difference between the University of South Dakota ($11,208 per year in state) and the University of the District of Columbia ($8,850 a year in state) versus Touro ($41,070 a year) or Thomas Jefferson ($38,700); this disparity means lending limits would not affect low-ranked schools equally, by any means. And indeed all the law schools, regardless of current rank, would likely find that traditional assumptions of prestige cannot hold steady in the face of loan limits: once applicants are forced to become more price sensitive, schools’ LSAT and GPA averages will adjust as students with high credentials more often choose lower-priced schools. Interestingly, looking at the first page of the US News rankings, there is not a huge tuition differential among the most prestigious schools. But beyond the most elite, tuition and average debt vary significantly and are less correlated with ranking than many people realize. With greater price sensitivity, there is likely to be a more significant correlation between cost and rank.

What does this mean for the future?

First, schools must take a hard look at their own loan dependence and should make contingency plans for the future. Schools must plan how to fund quality legal education in the event that loans become less available, and schools should also plan for ways to minimize the student loan burden even in the current era of unlimited lending. This may mean making some hard choices: some of the most effective innovations in legal education are also among the most costly, as Michael Lewyn notes in a recent comment on The Faculty Lounge. A school’s dependence on student loans can be roughly gauged by this chart, which shows the average indebtedness per 2010 graduate, along with an estimate of the percent of students taking out loans (students at schools on page 5 and after are below the national median in law school indebtedness). If a school’s average debt burden is $145,621 per student ($48,540 per year), what would the school’s budget look like if federal lending were capped at $40,000 per student per year? What if it were capped at $30,000 per year?

Second, schools, professors, and bar admissions committees should all be aware of the loan burdens faced by new graduates. Income Based Repayment can help ease the burden for many. Nonetheless, we should not ask students to take on a large debt burden without also providing transparent data about the monetary costs and benefits of that investment decision—and we should be mindful of the fact that law students are in fact making a very significant investment.

Finally, we should all step away from the current US News rankings. Brian Leiter and others have already pointed out many flaws in the current rankings. If the rankings are likely to look radically different in the future—and I think they are—then we certainly shouldn’t base current policy choices on the rankings as they look now. As my own law school’s dean has pointed out, applicants should look at the real value of what a law school has to offer: what are the areas where a law school’s program excels, regardless of ranking? The true strengths of individual law schools have often been overlooked in favor of attention to the school’s overall ranking, but such an approach is shortsighted. The decision to invest in a law school education is not just a monetary decision, and the benefits measured in the cost-benefit equation are not just monetary gains; educational value matters. Law schools that invest in improving their ranking without also improving their educational value shortchange themselves, shortchange their students, and make an unwise investment. When we develop law school programs, we must do so with an eye toward lasting value to the students.